Has the Gold Bug Bitten You?

The past one year has been really hard for gold investors. They have witnessed carnage in gold prices and have seen the value of their investments go down, day after day. In one of our older articles titled Why is Gold Price Falling? we had taken a detailed look at why the gold price is falling in the recent past. However, that is not the purpose of this article.

As collateral damage due to this fall in gold prices, individuals who had pledged their gold jewelry to make some quick cash to meet their funding demands have been caught unaware. The purpose of this article is to understand what problem these individuals are facing and how to handle the situation.

Before we begin: As you all may be aware, companies that grant loan against gold have been coming up in hundreds over the past year or so. Last year in June, I had written an article in this blog titled Tough Times Ahead for Gold Loan Companies where I had elaborated on these companies and the problems they face. It was just a matter of time before they ran into trouble and the inevitable has just happened in the past few weeks.

Who did this Gold Bug Bite?

The gold bug bit anyone and everyone who had recently pledged their gold jewelry at a bank or a gold loan company to get money.

Why is this Gold Bug Biting people?

The reason is simple – The Gold Loan Company Wants to Minimize its Losses.

Read this example from a banks perspective to understand the situation – before I actually explain what this bug bite is:

Let us say you run ABC Gold Loan Co, and I turn up at your branch to pledge 100 grams of Gold on 1st January 2013. Let us say, on that date, one gram of gold is being sold in the market at Rs. 3000/- and you are happy to give me a loan for 90% of the price value of the gold I am ready to pledge. Which means, you give me a loan of Rs. 2,70,000/- for the 100 grams of gold that I pledge with you. The difference of Rs. 30,000/- will be your cushion in case I default.

Sounds straightforward isn’t it?

Here comes the kicker…

Let us say, today 28th May 2013, the price of gold is only Rs. 2200/- per gram and I have just made interest payments in the past 6 months. So, the loan amount outstanding against my name is Rs. 2.7 lacs while the value of the 100 grams of gold I pledge with you is only Rs. 2.2 lacs.

Common sense would tell me that, it would be cheaper for me to let the loan default rather than pay 2.7 lacs for gold that is worth only 2.2 lacs. Isn’t it?

Gold Loan customers these days are doing this exact calculation outlined above and are willing to default on their loans instead of repaying their loan obligation.

What is this Gold Bug Bite?

Banks and Gold Loan companies are sending out letters to their loan customers to make either a part or full repayment of their loans to redeem their gold jewelry.

Can the Bank or Gold Loan Lender ask for this kind of repayment?

Yes, they can. If you read the loan terms & conditions carefully, there will be a clause which would say that the bank or the lender at his/her discretion can ask for part or full repayment of the loan at any time they want.

This, at their discretion means – they can ask for part or full repayment if they feel the value of the collateral held isn’t enough to meet the loan.

Go back to the above example, you as the owner of ABC gold loan co, will be sending me a letter stating that the value of the gold I have pledged isn’t enough to offset the loan outstanding. So, I should make a part or full repayment of my loan money. If I do not have surplus funds to meet your repayment needs, I may have to let the loan go into default…

What are my options – As the Loan Customer?

Option 1: The first option would be to minimize losses from my side and let the loan default because, I will actually be paying more money than what my gold is worth.

Limitations: None. You can do it anytime you want

Problem Due to Option 1: If I default on my loan, my credit history will go for a toss and no one will be willing to give me a loan in future. Banks and lenders these days are giving more and more importance to our credit history before actually giving us loans.

So, Option 1 is a REALLY BAD IDEA…

Option 2: Make a part or full repayment of the loan and redeem your gold if you have surplus cash available.

This is the best or easiest option because the bank or lender will be more than happy to close the loan or accept part repayments to keep their margins safe.

Limitations: You cannot do this if you do not have surplus cash

Problem Due to Option 2: None

Option 3: Pledge more Gold
If you do not have surplus funds to make a part or full repayment, you may consider pledging more gold as collateral to cover your loan. Most lenders will be happy to accept more collateral to cover the loan they have granted you.

Limitations: You cannot do this if you do not have surplus Gold

Problem Due to Option 3: None

From a borrowers perspective, these are our only options. Though we can let the loan default, we will end up making more damage to our credit history than the small profit we may make. So, try to liquidate your savings or borrow money from friends and family to do a part repayment as per Option 2.

Remember: The bank or lender cannot force you to do a full repayment immediately. They can only ask for part repayment or additional collateral to cover the loan amount. They may try to intimidate you into submission but the fact is, as a customer you have rights. It is a collateralized loan and the maximum liability from your side is – forfeiting the item you pledged as collateral if you default. They cannot bully or intimidate you any further. You can tell them that the best you can do is make a part repayment or pledge additional gold to cover their margin and that is all. If they push too much you will let the loan default and they can sell your gold to cover their losses.

Chances are that the bank or the lender will come down on their demand and let you do a part repayment or pledge more gold.

Best Wishes!!!

Tough Times Ahead for Gold Loan Companies - All Your Questions Answered

After reading the last article titled “Tough Times Ahead for Gold Loan Companies” there might be some questions running in your mind. I have tried to answer some of the main questions. If you have any further questions, feel free to leave a comment and I will be more than happy to answer them…

1. Why do customers prefer these Gold Loans?

Let us say I am in urgent need of cash and taking a Personal Loan would take at least 4-5 working days after I submit all the necessary paper work. While I am wondering what to do, my Mom tells me that, I can pledge her Jewels in the nearby Gold Loan Co and get some cash quickly. I take 5 sovereigns (40 grams) of her jewellery and visit the place. The person in the Gold Loan section checks the weight of the jewellery and its quality and gives me a quotation. The price of gold today is going at over Rs. 2600/- per gram which means the necklace is worth a little over 1 lakh. The Gold Loan Co offers me quick cash of Rs. 75000/- on hand and takes possession of the jewellery. I will have to pay a monthly interest and can redeem my mom’s necklace once I repay them the principal of Rs. 75000/-

All things done & dusted in a few hours. Some Gold Finance Companies even advertise super-fast service times like – “Get Cash in 15 mins” and so on to attract more customers.

Most Importantly – This is an extremely better option when compared to loan sharks and illegal lenders who charge exorbitant interest rates and harass customers.

2. How does the 60% Loan to Value Ratio affect Gold Loan Cos?

If, I were a customer, I would have to pledge more gold than before to borrow the same amount of money. Similarly, these companies would have to stop selling certain products which offer more than 60% the value of the gold as loan. Existing customers who are used to getting around 75% of the gold value as loan will end up disappointed as well which will not do much good for the business.

3. Is this 60% Loan to Value Ratio applicable to Banks that offer loans against Gold?

No. This ruling by the RBI is applicable only to NBFC’s that offer loans against Gold. Before you say, this doesn’t make sense, just read the next question/answer which will clarify further on this.

4. Why doesn’t this 60% LTV Rule apply to Banks?

The RBI Feels that, these Gold Loan Cos are growing at an alarming pace and them granting loans of over 75% of the Gold value might adversely affect their business. This whole loan thing is based on the fact that Gold price will not go down. Let’s say, I borrow 10 lakhs against 12 lakhs worth of my Gold Jewels. After a few months, the price of Gold tanks and my gold is worth only 9 lakhs today while the loan I have taken is still worth 10 lakhs only. Will I repay 10 lakhs to take possession of my gold that is worth 9 lakhs? Probably not. In such a situation, such NBFC’s will be forced to declare bankruptcy. To avoid such a situation RBI is setting this 60% LTV ratio so that these gold loan cos have some buffer.

The second part about Banks not being brought under this rule is because – banks can accept customer deposits and as a result have much more cash at their disposal than these Gold Loan Cos. As a result, they can absorb/survive a much higher impact than NBFCs. So, RBI does not mandate this 60% LTV ratio for Banks.

Technically & practically speaking a rule must be common across the board but unfortunately in this case it is lopsided against these Gold Loan Cos.

5. With no upper limit on LTV, can commercial banks kill the private gold loan cos?

Though it is practically possible, banks usually don’t lend amounts beyond 15 lakhs as loan against gold. This upper limit on the loan value is something that almost all banks have. Private gold loan cos don’t have this limit. They will lend you as much money as you want provided you have enough gold to pledge…

Also, banks have a lot of formalities which private lenders don’t. Can you imagine walking into State Bank of India or any other Public Sector Bank and walking out with money in say even 2 hours? I must be out of my mind to suggest something like that. Even private sector banks will make you wait at least a few hours to disperse the funds. Whereas, these gold loan cos will give you cash in a matter of minutes or at most 1 or 2 hours.

So, customers wanting quick & unlimited money supply would still prefer these guys over banks.

6. Does the Capital Adequacy Requirement increase to 12% affect large players like Muthoot or Manappuram Finance?

No. Muthoot maintains a CAR of around 13% and Manappuram maintains a much higher CAR of 18%. So, there will be no impact on either of these companies.

7. Banks have been offering loans against gold for years but, these Gold Loan Cos have out-grown the gold loan lending arm of banks. How was this possible?

There are numerous reasons. Some are:

a. Quicker service – Banks concentrate heavily on their main business like bank accounts, deposits etc. and grant gold loans as a parallel activity. So, service will not be top class. Whereas, the only job these gold loan cos have is granting loan against gold. So they will be much faster.
b. Well-Trained staff – the staff of a gold loan co can check the purity of gold and value it accurately while banks depend on experts who are not full time bank staff. So, there is bound to be some delays
c. Lesser Charges – Banks usually charge a processing fee (1% or so) while these Gold Loan Cos don’t. Also, banks charge a penalty if the loan is repaid within a certain duration (say 6 months or so) whereas Gold Loan Cos don’t.
d. Lesser Salaries – Salaries & Perks that Bank Staff receive a much higher when compared to what the staff of Gold Loan Cos get. So, companies can offer loans at competitive rates when compared to Banks.

Tough Times Ahead for Gold Loan Companies

How many of you have actually noticed the fact that companies that issue loan against gold like Manappuram or Muthoot have been sprouting up in almost every single locality in your city? Over the past 5 years, these companies have grown in leaps and bounds. The sky-rocketing price of gold and easy access to cash without much of a hassle if customers pledge gold has fuelled the growth of these companies and they have grown to such an extent that, they have even gone public and issued Equity Shares. Though this might sound an Amazing Growth Story, the future for these companies doesn’t look like it will be as fast paced as it has been over the past few years. The purpose of this article is to analyse on that aspect…

How Does a Gold Loan Work?

This is something almost 99% of you would know, but for the sake completeness, I am writing this section.

The company (or Bank) take possession of customer’s gold (Jewellery) and grant loans of around 70% or more of the value of the current value of Gold as loan. The customer will pay a monthly interest (around 2-3% of the sum borrowed) and can take their gold back when they settle the entire amount due (principal borrowed + interest).
If I fail to repay the interest for a period of 3 consecutive months (depends on the company) they have the right to sell my gold and offset their loan cost and reduce their losses

What is a Gold Loan Company?

A Gold Loan Company is one that is into the business of lending money against Gold. Though Banks also lend money against gold, they also accept deposits and provide bank accounts to customers. These Companies do not provide such services. The only service they provide customers is loan against gold jewellery. As a result some people even refer to them as NBFC’s (Non-Banking Financial Companies)

Tough Times Ahead for Gold Loan Cos

You might be wondering if what I have put in the title is true… Are you?
If you are, I wouldn’t be surprised and in fact that is a good start for the both of us. The following are some reasons as to why the following few months (or maybe even years) are going to be tough for these companies.

Reason 1: Regulatory Concerns

Seeing the super-fast growth of these companies (partly due to very little regulations) the Reserve Bank of India has starting setting up guidelines for these companies. Though the RBI Governs all Banks in India, these gold loan cos were not entirely under the RBI’s jurisdiction. Now, the RBI has started setting up some rules. As a result, these cos will be facing some uncertain times in the near future at least until there is some clear cut clarity on the kind of regulations they are expected to follow.

A Full list of the recent regulatory changes for gold loan cos is available at the end of this article.

Reason 2 – Explosive Growth is not permanent

Any new industry fancies customer interest for a few quick years and then starts to stabilize. These gold loan cos too are part of that cycle. The arrival of these companies that offer much higher amounts against Gold sparked customer interest and over the past few years, these companies have grown at super-duper speeds. However, now things are starting to stabilize.

I am not saying that there will be no growth. All I am saying is, the growth will not be as spectacular as it was in the past 2 to 3 years.

Reason 3 – Competition

With the arrival of multiple Gold Loan Lenders, competition is pretty heavy. Newer entrants are offering much lower interest rates than the veterans. As a result, customers in need of a better bargain are flocking towards the new entrants because the interest they are paying is comparatively lesser. Due to heavy competition, all these lenders are forced to cut their rates which in a way is good for the customers.

Reason 4 – Growth in Gold Loan Lending by Commercial Banks

A few years back, only a few select private banks offered loan against jewellery. But, things have changed and almost all banks these days are offering loans against gold jewellery. With no upper limit on Loan-to-value ratio (like Gold Loan Cos) banks can lend a much higher value loans for the same quantum of gold to customers. So, customers might choose to borrow from banks instead of these gold loan cos.

Recent RBI Rulings that might affect Goal Loan Cos

Ruling No. 1:
The RBI came up with a new ruling on 21st March 2012 which prohibits exceeding a 60% Loan-To-Value Ratio. This means, the RBI prohibits Gold Loan Cos from lending more than 60% of the value of Gold Pledged by the customer (It was 75% earlier).

Impact:

The amount that customers can borrow will come down. In other words, a customer has to pledge more gold in order to get the same loan amount as to what he/she got just a few months back.

Ruling No. 2:

The Tier-I Capital Adequacy Ratio (CAR) requirement has been increased to 12% (It was 10% earlier). This will be effective April 1st 2014.

Impact:

CAR is nothing but the amount of liquid cash these companies have to maintain as a ratio of the loans in their books. For ex: If XYZ Gold Finance Co has granted gold loans worth 10 crores, they had to keep liquid cash worth at least 1 crore to meet the Tier I CAR. As a result of this new ruling they have to keep 1.2 crores (additional 20 lakhs) for the same loan amount of 10 crores.

This will be a huge dent in their books. Instead of using surplus cash to lend more loans and increase revenue, they will be forced to keep the money to meet capital adequacy requirements. Moreover, this 10 crores is probably the amount of loans a big gold finance co might grant in a week or even less. So, if we consider the amount of liquid cash they need to keep to maintain the CAR Ratio, the number might run into a few hundred Crores.

Ruling No. 3:

RBI has prevent Gold Loan Cos from granting loans against Bullion

Impact:

Customers who have gold bars (bullion) will not be able to borrow money against it. Only Jewellery can be used to borrow money. This will affect the small minority that use bullion to take loans.

Future for Gold Loan Cos?

An RBI Constituted working committee is working on formulating a list of rules & regulations for these gold loan lenders. This is expected to be released by July or August of 2012. So, until then, times will be uncertain for these guys. Even after the rules are made public, these companies will be forced to make radical changes in their operations which might affect their profits for at least one or two years. So, if you are an investor looking to invest in these gold loan cos, it would be a good idea to wait until end of this year to see how things work out for these companies before investing in them.